Shareholder Bylaws: Mechanics, Limitations and Pragmatic Benefits

Before looking directly at the normative benefits of shareholder-enacted bylaws regulating corporate political activity, it’s worth providing some background on the bylaw power itself. Corporations are predominantly republican institutions. Shareholders elect the board annually, but once elected the board has broad authority to manage the business and affairs of the corporation. In fact, ordinarily, the board need not heed the desires of a majority of the shareholders. Some special matters (such as certain mergers or sales of substantially all of the corporation’s assets) require shareholder approval, but even then the shareholders’ role is reactive; these transactions must be proposed and approved by the board.

Corporate bylaws are functionally the sole exception to this general governance framework. The bylaws, as one of a corporation’s constitutional documents, are contractually binding on shareholders, management, and the board. In most states, shareholders have the right to propose, amend, or repeal the corporation’s bylaws. Moreover, shareholders can do so unilaterally. Thus the bylaws provide shareholders with a limited form of direct democracy (albeit one vote per share, not per shareholder) within the corporation.

The scope of this power is, however, uncertain. In Delaware – a key corporate law jurisdiction – the statute is notoriously unhelpful, and case-law has not conclusively resolved this open question. The weight of academic and judicial commentary suggests that there is a finite set of bylaws that can be enacted legally by shareholders, though some recent cases call into question the extent that such bylaws can restrict managerial decision-making authority. In any event, the validity of bylaws regulating corporate political activity has not yet been decided by any court. In an earlier paper, I presented a case for the legality of such bylaws. There are also several pragmatic benefits to empowering shareholders in this fashion.

First, the shareholder bylaw power is a limited intrusion on managerial authority. Because bylaws require affirmative, majority shareholder action, the board retains plenary discretion unless a broad consensus develops among shareholders. Frivolous or extreme proposals are therefore unlikely to pass.

Second, bylaws are the least sticky method of regulating corporate political activity. Unlike mandatory rules, bylaws are easily undone by shareholders themselves if they are dissatisfied with the outcome or if a new cohort of shareholders hold different preferences. Stale bylaws can also be undone by the board, subject to its fiduciary obligations, if shareholders grow apathetic. Additionally, if certain types of bylaws prove particularly pernicious, the board and shareholders can collectively prohibit their adoption ex ante by pre-empting them in the certificate of incorporation (another of the corporate constitutional documents, which trumps the bylaws but can only be amended if both shareholders and the board agree).

Third, private ordering allows firms to experiment. It is highly unlikely that a one-size-fits-all approach to corporate political activity is desirable. The most effective regime almost certainly depends on firm- and/or industry-specific factors. Of course, there is a wide range of plausible bylaws, including tailored disclosure obligations (e.g., straight disclosure or disclose-and-explain obligations), limits on types of political activity (e.g., lobbying is ok, but electioneering is not), procedural regulations such as shareholder or independent board approval, caps on spending, or plain bans on corporate political activity. It is impossible to know a priori the full consequences of adopting any of these regimes, but allowing shareholders to privately order their preferences allows corporations to learn by transacting. This experimentation also provides important information to the market and other companies about the merits of tested bylaw regimes.

Finally, authorizing shareholders to enact binding bylaws may improve discourse within the firm concerning the costs and benefits of corporate political activity. When the board is required to negotiate, valuable information is shared among the interested parties. When shareholders are more informed about the activities within their firms and the consequences of potential regulatory actions, they are likely better able to make reasoned decisions about the appropriate path forward. And, such discourse may better inform the public concerning corporations’ political activities.

While these pragmatic benefits pertain – more or less – to many types of shareholder-led private ordering, there are also unique normative justifications for limited shareholder empowerment to regulate corporate political activity. In the next post, I’ll turn to the problem of agency costs.

Lawrence — thanks! Yes, I view this approach as a preferable alternative to mandatory regulation through the securities laws. Corporate political activity poses real corporate governance concerns, but there’s also substantial empirical uncertainty about the consequences of various forms of internal regulation. In those circumstances, I think a cautious but enabling approach is best.

Disclosure is probably a good idea for most companies, but I’m skeptical of a static, uniform and mandatory rule. Also, in the aftermath of Business Roundtable, I worry about the efficacy of SEC regulation in any event. Plus, for some companies, disclosure may not be enough; shareholders may want or need additional ex ante control over political activity. But, I’m leery of imposing mandatory rules (or drastically changing the current corporate law defaults) in this regard as well.

I also think there may be an important expressive effect in telling shareholders that they are entitled to make this choice for themselves.